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Implementing IFRS 9: a Guide for Lessors Implementing IFRS 9: a Guide for Lessors

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Implementing IFRS 9: a Guide for Lessors Implementing IFRS 9: a Guide for Lessors Implementing IFRS 9: a guide for lessors Implementing IFRS 9: a guide for lessors IFRS 9 brings together the classification and measurement, impairment and hedge accounting sections of the IASB’s project replacing IAS 39 Financial Instruments: Recognition and Measurement and all previous versions of IFRS 9. IFRS 9 is effective for annual periods beginning on or after 1 January 2018 and will have a significant impact on lessors, specifically in relation to the following areas: 1. Classification and measurement 2. Impairment of financial assets 3. Hedge accounting 4. Debt modification clarification For more insights see www.eyfs.ie/aviationfinance 1 1. Classification and measurement IFRS 9 introduces a new model for classifying financial assets. In respect of financial liabilities, all IAS 39 requirements have been carried forward to IFRS 9. The standard introduces principle-based requirements for the classification of financial assets, using the following four measurement categories: i. Debt instruments at amortised cost ii. Debt instruments at fair value through OCI (FVOCI) with cumulative gains and losses reclassified to profit or loss upon derecognition iii. Debt instruments, derivatives and equity instruments at FVTPL iv. Equity instruments designated at FVOCI with no recycling of gains and losses upon derecognition The classification of financial assets is summarised in Illustration 1 below. Debt (including hybrid contracts) Derivatives Equity ‘Contractual cash flow characteristics’ test (at instrument level) Pass Fail Fail Fail ‘Business model’ test (at an aggregate level) Held for trading? 1 Hold-to-collect 2 BM with objective that results 3 Neither (1) Yes No contractual in collecting contractual cash nor (2) cash flows flows and selling financial assets Conditional fair value option (FVO) Yes FVOCI option elected? No elected? No No Yes Amortised FVOCI FVOCI FVTPL cost (with recycling) (no recycling) Illustration 1 – classification of financial assets 2 The typical financial assets held on the balance sheet of lessors impacted by IFRS 9 include the following; Name IAS 39 classification IFRS 9 classification Unrestricted and restricted cash Amortised cost Amortised cost PPN assets Amortised cost FVTPL Derivative financial assets FVTPL FVTPL AFS assets/Investments at FVOCI Available for Sale FV through OCI Amounts due from related parties Amortised cost Amortised cost Trade receivables Amortised cost Amortised cost Loans/Notes receivable* Amortised cost Amortised cost *Assuming collecting principal and interest only. The above assets held at amortised cost under IAS 39 should, the impact of this change in measurement will disappear based on the typical fact pattern of these assets, meet the on consolidation. This will still need to be considered in the business model test, in that they are held to collect contractual standalone financial statements of the entity holding the PPN cashflows and these cashflows are solely payments of principal assets, or indeed in the company balance sheet of the parent and interest (‘SPPI’). Hence, lessors will continue to account if the parent company balance sheet requires inclusion in the for these assets at amortised cost, with the exception of PPN financial statements. assets. The assets accounted for as “AFS” under IAS 39 will typically PPN assets typically entitle the holder to the residual returns be categorised as FV through OCI under the business model in a structure in exchange for the most subordinate class of test. This new category has similar objectives to the IAS 39 debt in a structure and as such are akin to equity returns. As category, the objective being collecting contractual cash flows a result, PPN assets will be measured at FVTPL as the above and selling financial assets with those contractual cashflows conditions (SPPI) of the business model test are not met. Many meeting the SPPI test. Those assets which were previously groups will include these assets as part of their structure. classified as FV remain being classified as FV. In the majority of instances, given the structuring of PPN assets by most lessors through the group but not externally, 3 2. Impairment of financial assets The new impairment model in IFRS 9 addresses the IASB’s key 1. General Approach concern that the “incurred loss” model in IAS 39 contributed The general approach will be applied to all loans and to the delayed recognition of credit losses which arose as a receivables not covered by another approach. In practice for result of the financial crisis. Therefore, the new impairment lessors, it is not expected that cash will be considered for requirements are based on a forward-looking expected credit impairment. Therefore, lessors will apply this approach to the loss (ECL) model. following financial assets: IFRS 9 defines credit loss as the difference between all • Investment at FVOCI contractual cash flows that are due to an entity in accordance • Amounts due from related parties with the contract and all the cash flows that the entity expects to receive (i.e., all cash shortfalls), discounted at the original • Loans/Notes receivable EIR. It goes on to define ECLs as ‘the weighted average of Under the general approach, entities must recognise ECLs in credit losses with the respective risks of a default occurring as two steps as illustrated below. the weights’. The expected cash flows will include cash flows from the sale of collateral held or other credit enhancements For credit exposures where there has not been a significant that are integral to the contractual terms. increase in credit risk since initial recognition (i.e., ‘good’ exposures), entities are required to provide for credit losses In applying the IFRS 9 impairment requirements, an entity that result from default events ‘that are possible’ within the needs to apply one of the following approaches: next 12-months (a 12-month ECL – stage one in the illustration 1. The general approach below). For credit exposures where there has been a significant increase in credit risk since initial recognition, a loss allowance 2. The simplified approach is required for credit losses expected over the remaining life 3. The credit adjusted approach of the exposure, irrespective of the timing of the default (a The credit adjusted approach will most likely not apply lifetime ECL – stages two and three in the illustration below). to lessors and has not been discussed in this paper. The The loss allowance reduces the carrying amount of the application and impact of the remaining two approaches for financial asset in all three stages described below. lessors have been discussed below. Stage 1 Stage 2 Stage 3 Loss allowance updated at 12-month ECL Lifetime ECL each reporting (credit losses that result date from default events that are possible within the next 12-months) Lifetime Credit risk has increased significantly ECL since initial recognition criterion (whether on an individual or collective basis) + Credit-impaired Interest Effective Interest Rate EIR on gross EIR on gross revenue (EIR) on gross carrying carrying amount amortised cost recognised amount (gross carrying amount less loss allowance) Change in credit risk since initial recognition Improvement Deterioration Illustration 2 – General approach for impairment of financial assets 4 So what does this mean for lessors in practice and how can The ECLs in respect of financial assets held at amortised cost a lessor identify whether a 12 month of lifetime ECL should are recognised as a loss allowance against the gross carrying be applied? amount of the asset, with the resulting loss being recognised in The first consideration is to assess what in practice would profit or loss. evidence a significant change in credit risk. Firstly any arrears For debt instruments measured at FVOCI, the ECLs do not greater than 30 days past indicate a movement to stage two. reduce the carrying amount in the statement of financial For a lessor holding assets with counterparties who have credit position, which remains at fair value. Instead, an amount equal ratings (or where counterparties liabilities themselves have a to the allowance that would arise if the asset was measured rating), a deterioration of the credit rating of the counterparty at amortised cost is recognised in OCI as the ‘accumulated would indicate a movement to stage two. Other indicators impairment amount’. This means that impairment losses (or include: reversals) are charged to profit or loss with a corresponding • Existing or forecast adverse changes in business, financial or entry in OCI. economic conditions that are expected to cause a significant Collateral is not considered when assessing whether a change in the borrower’s ability to meet its debt obligations. financial asset is classified as stage one, two or three; • An actual or expected significant change in the operating however, collateral can be considered when considering what results of the borrower. impairment provision should be applied. • An actual or expected significant adverse change in the regulatory, economic, or technological environment of the 2. Simplified Approach borrower. The simplified approach is required for certain qualifying trade • Significant changes, such as reductions in financial support receivables, IFRS 15 contract assets and lease receivables. from a parent entity. IFRS 9 allows the use of a provision matrix as a practical • Significant changes in internal price indicators of credit risk expedient for determining ECLs on trade receivables. Many as a result of a change in credit risk since inception. corporates may already use a provision matrix to calculate In many instances there may be limited information available their current impairment allowance, but they will now be for a counterparty. The standard is clear that in certain required to consider how they can incorporate forward-looking circumstances, qualitative and non-statistical quantitative information into their historical customer default rates. Entities information may be sufficient to determine that a financial would also need to group receivables into various customer asset has met the criteria for the recognition of lifetime ECLs.
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